Why we must use outstanding coin supply and not circulating supply to calculate market cap?
Short answers is that circulating supply is fundamentally inappropriate here.
Let’s examine why.
Here is CoinMarketCap’s explanation for usage of Circulating Supply (see item 7 of their methodology):
“We have found that Circulating Supply is a much better metric than Total Supply for determining the market capitalization — Coins that are locked, reserved, or not able to be sold on the public market, are coins that cannot affect the price and thus should not be allowed to affect the market capitalization as well. The method of using the Circulating Supply is analogous to the method of using public float to determine the market capitalization of companies in traditional investing.”
Public float approach cannot be used to measure size of companies. Analogously Circulating Supply cannot be used to measure size of crypto networks.
Have you ever seen Amazon, Microsoft, Google or Apple compared by public float capitalization? No.
Index funds are major consumer of stock index data.
Until 2004 S&P 500 index was weighted by total market capitalization. Then they transitioned to free float adjustment. Here is how S&P Index Committee chairman explained the transition to free float adjustment:
“The sense of most index users is that float adjustment reduces the costs of running index funds and ETFs because stocks with less float — and therefore less liquidity — have lower weights in the index,” said David Blitzer, chairman of the S&P Index Committee, in an interview.
In other words — index funds have to copy the composition of index that they track. If a corporation with 10% free float is included in the index fully, it will be hard for funds to buy sufficient # of shares of this corp because only 1/10th is available for purchase.
If we are to create a crypto index, then circulating supply is a proper metric to weigh index constituents. In other cases we must use outstanding shares to calculate Market Cap of crypto networks.